During the first internet boom, the business model of South Park's Underpants Gnomes was commonplace, as scores of companies flooded the marketplace, sustained purely by the promise of future profits that would somehow magically appear. As Grant Williams scoffs in his most recent letter, it was the corporate embodiment of George Costanza’s “yada, yada, yada”: “First we build a company... yada, yada, yada... we make billions.” Of course, most of these companies went the way of the dodo; but remarkably, a mere 14 years after the bursting of the original internet bubble, there are signs of what Yogi Berra so beautifully referred to as “déjà vu all over again” - signs which some real heavyweight financial minds have recently highlighted...
(Seattle Times): Venture capital rising to levels not seen since 2001. Companies with no profits going public. Billions of dollars being paid for startups.
These and other signs that the tech boom may be taking an irrational turn are leading some notable investors to utter the dreaded word “bubble,” waking up the ghosts of an era many in Silicon Valley would prefer to keep buried.
Has Silicon Valley once again lost its collective mind?
Hedge-fund manager David Einhorn thinks so.
“There is a clear consensus that we are witnessing our second tech bubble in 15 years,” he warned in a note to his clients in late April. “What is uncertain is how much further the bubble can expand, and what might pop it.”
Of course, as we saw in 1998/9, there are plenty of people who believe in fairy tales, and they are happy to explain why THIS time is different:
Venture capitalists and entrepreneurs insist the Silicon Valley tech economy is not in bubble territory. Yes, they misjudged just how fast the Internet would change the world a decade ago and let things get a little bit out of hand.
But this time, they say, the revolution of mobile and cloud services justifies big, bold bets. And most of the companies going public are profitable, with real businesses that are transforming the way we live.
To some tech insiders, the region’s economy is in a “Goldilocks” moment. Not too hot. Not too cold. Enough of a boom to be just right.
Seriously?... Goldilocks? Again with that?
...
The day that rationality returns to investing in technology stocks will be the day that we see some high-flyers (which had previously been given a pass on their poor performance because the promise of a bright tomorrow was just SO compelling) fall to earth in a hurry.
However, so as not to call out any specific companies, I am going to take the South Park approach and lay out a hypothetical fable about one such giant, highflying corporate darling which has been embraced for its willingness to follow the Underpants Gnomes’ ingenious business plan.
Let's call this company... Spamazon
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But is there any point in going over the fictional metrics of a fictional internet behemoth just to belabor a point? After all, it’s not as though it actually matters in the real world. And it’s not as if Spamazon is the ONLY fictional company purusing the Underpants Gnomes’ business playbook.
Take Flutter, for example.
The Flutter business model is eerily similar to that of Spamazon:
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This surge in companies being awarded huge valuations based solely on the fact that, like the Underpants Gnomes, Phase Three of their business plans calls for gargantuan profits has reached a level seen only once before.
Can you guess when that was?
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Yep... the share of companies coming to market with negative earnings reached 74% in early 2014, a level surpassed only in........ drumroll, please........ February 2000.
Eventually, momentum based upon future promises will cease, and when it does (or if it has) then anybody taking a long hard look at the stocks they bought during the mania will find only one word to describe the quality of many of those companies:
Pants.
Full Grant Williams Letter below...